In a Dickensian chapter for the stock market, we are in the middle of an earnings season that illustrates both the best of times and the worst of times for investors.
On the plus side, second-quarter gross domestic product (GDP) growth was the fastest since 2014, and research firm FactSet estimates that earnings growth in S&P 500 Index
SPX, +0.49%
companies will top 23% in the second quarter for the best showing since 2010.
On the negative side, many fear the high-water mark of GDP growth is unsustainable amid trade tensions, and that high-profile earnings misses from the likes of Facebook
FB, +0.89%
and Netflix
NFLX, +0.74%
could do lasting damage to confidence in the tech sector and the market as a whole.
To be fair, this duality is not new on Wall Street. The old yarn about stocks climbing a “wall of worry” is thrown around for good reason, and at its core any market is fundamentally made up of both buyers and sellers.
But today, with the markets seemingly at an inflection point after high-stakes earnings and with high-stakes trade talks in Washington, it’s worth looking at both sides of the trade.
Here are five serious causes of concern for stocks in 2018, and five reasons you may not need to worry so much after all.
Five reasons to worry
GDP growth is about to stall: While Donald Trump oversimplified the latest GDP print into proof of his great deal-making skills, the devil is in the details. For starters, the 4.1% surge was at the low end of many estimates, including coming up just shy of the MarketWatch forecast of 4.2%. Next, the growth was driven by a short-term pop in exports as trade partners front-loaded their purchases of U.S. goods in the second quarter in anticipation of tariffs and other trade impediments in the second half of the year. And, of course, the short-term pop of tax cuts passed in late 2017 are now on the books and starting to wane in impact. All that will make growth much harder to come by later this year.
A new housing bubble: The financial crisis and resulting crash of 2008 was predicated on risky mortgages creating artificial demand. The current real estate bubble is being driven by record lows on the supply side, however, as buyers clamor for the few quality listings in their area. However, as one agent recently told CNBC: “A bubble happens when you have the prices going up without the demand going up.” That’s because if, and when, demand drops or supply widens out, home prices become unsustainable in a hurry. Any number of factors, including a drop in consumer confidence or increased borrowing costs thanks to higher interest rates, could sap demand in 2018 and lead to a lot of pain as a result.
Record valuations: Even after recent volatility, many market experts are still concerned that stock valuations are simply too far out of whack with historical norms. One expert recently noted that from 2009 to 2018, the S&P 500’s price-to-sales ratio soared more than threefold, from 0.7 to 2.4 — the highest on record. There’s also Nobel-winning economist Robert Shiller who has warned for some time that cyclically adjusted P/E, or CAPE, is at unprecedented levels. Other similar metrics show the market is in many ways more overvalued than before the 2008 meltdown and is approaching dot-com levels.
Big trouble for big tech: The very public and very serious declines in some big tech stocks, including Netflix and Facebook, didn’t just burn individual stockholders. Their declines also create broader problems for market-cap-weighted indexes that are heavily reliant on big tech stocks. And now that these stocks have shown that they are not bulletproof and in fact face very real struggles to achieve growth, investors who have been perpetually overweight Big Tech have some serious cause for concern.
No news is not good news: Add up all these items of uncertainty, and it’s no surprise why Morgan Stanley recently warned that Wall Street’s rally is running into “exhaustion” and that “investors (are) finally faced with the proverbial question of ‘What do I have to look forward to now?’ ” In the absence of good news to counteract the creep of negativity, why should anyone expect this rally to resume in earnest?
Five reasons the worries are unfounded
Remember the volatility crisis of 2010? To those concerned about the return of volatility in 2018 or the big moves in names like FB and NFLX, it’s worth looking back to the “flash crash” of 2010. That was real volatility, with many worried about structural problems for the market itself thanks to algorithmic trading and with the CBOE Volatility Index
VIX, +1.87%
spiking to above 40. So close to the terrible declines of 2008, you’d think it would have really shaken Wall Street to its core. But even the robots couldn’t kill the rally, as investors ultimately bid up the S&P 500 to a roughly 15% return that calendar year.
Remember the global scare of 2011? While the current politics of the White House trade war are certainly troubling to many, the actual economic impact isn’t quite a doomsday scenario. But as is so often the case, investors love to freak out about geopolitics — just like they did in 2011, when the European debt crisis was all anyone could talk about and the death of the euro was nigh. Wall Street survived the very real international challenges of 2011 and will again in 2018. Don’t let your personal politics fool you into thinking the global economy is doomed.
Remember oil stocks and energy junk in 2015? The FAANG stocks (Facebook, Amazon, Apple, Netflix and Alphabet’s Google) clearly have a lot of mindshare on Wall Street, but it’s naïve to think they alone — or any small group of stocks — can decide the fate of the stock market. Think back to declining crude oil prices and epic declines for many energy stocks in 2015. There was fear that the pain of this sector would spill over into all parts of the market via cascading defaults that sparked a broader credit crisis, and that the bond market itself would roll over. That never happened, obviously. While popular vehicles like the SPDR Barclays High Yield Bond ETF
JNK, +0.20%
are indeed down slightly since 2015 thanks to rising rates driving down principle values of all bond funds, the junk bond market has remained popular — and, as always, broader markets have proved resilient even if individual companies and sectors fall out of favor occasionally.
Remember the rate worries of 2016? There remains a lot of dithering about the effect of higher interest rates, the possibility of a “great rotation” out of riskier stocks and into more comparatively stable bonds. But starting with the first rate increase at the end of 2015, the Federal Reserve has been adept at communicating expectations — and both stock and bond markets have been resilient in the face of the daunting task of normalizing rates after an unprecedented era of easing. If you think a few 25-basis-point increases will roil capital markets or send prospective home buyers packing, you haven’t paid attention for the past three years.
Remember the perennial permabears? Beyond debating specifics, it’s important to remember that pundits who have bet against this bull market have an incredibly poor history of identifying true warning signs. Sure, maybe there are signs for concern. But hysterical headlines about a “1987-style crash” or the Dow Jones Industrial Average
DJIA, +0.43%
crashing 10,000 by the next election are just ridiculous, particularly because both of those examples are more than five years old! There is a cottage industry of pundits who get paid to peddle fear, and seeing disaster in each modest decline or poor economic report is bad for your blood pressure — and, ultimately, bad for your portfolio.
Source : MTV
